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What Does “Contract for Difference” Mean in Trading?

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If you have ever been interested in making money online, you must have heard about various sorts of trading. Among types of trading available online for the masses, CFD Forex and other asset-based trading have become quite prominent for their accessibility and strong potential. So, here are the basics of CFD trading.

Assets and Derivatives

Let’s start with assets. When you have some oil, gold, or foreign currency to sell and receive some money for it, this is an asset. Assets are what you can directly use in your life, so they have a certain price. Or not as certain? That’s where derivatives step in. 

What’s a derivative? It’s a contract based on somebody’s obligation to buy or sell some asset at some definite or indefinite moment in the future. The thing that makes derivatives easy to operate (especially online) is the absence of physical assets.

Let’s imagine this:

Faith Based Events
  • You sign a so-called futures contract to buy, say, a certain amount of gold for some fixed price.
  • When the moment comes, the market price of gold has grown. It turns out that you are buying gold cheaper than everyone around, so you can easily resell it for profits.
  • You resell this gold to the very seller you have bought it from, but at the current market price, that is, for more money.
  • The gold remains where it was. But you receive the difference between the prices, except for (as it usually is) some commission fee for conducting the deal.

In our example, the gold you have bought and resold physically exists, but derivatives function even if it only exists virtually. They cannot be eaten, driven, burnt for energy, but they can make you money. And they are easy to handle online.

Contract as an Asset

And now let’s take a step further. Suppose you have a contract like described above, and you sell your rights (and the counterpart’s obligations) to someone else, for a certain sum. The price of this contract depends on the market, but selling a contract does not oblige either side to buy or sell real assets – only to pay or receive the price difference when the moment comes. These contracts are tradeable, and probably the most tradeable online, without physical interactions. 

 And another step: remove the closing date. Instead, one side has the right to demand it at any moment. Will you buy such a contract? Maybe, if you think you will benefit from having prices move in the direction you expect. Then you can close these contracts the moment you find them.

 But how does it work in the end? For a trader at a terminal (that is, for you), it looks like this:

  1.     You choose the market (that is, the assets to trade)
  2.     You consider whether the price of a certain asset is going to rise or to fall
  3.     If you think it will rise, buy. If you expect the price to fall, sell.
  4.     Define a stop loss. This means that when the price reaches a certain level of loss you close the deal while your loss is survivable. We’ll talk later on why it’s necessary.
  5.     Close the trade when you think the moment is right.

As you see, no real assets are involved. It looks like gambling where you just place your bets on a random event. The difference is that the events here are not random. It’s the trend you need to define and act according to it.

 Big Deals with Little Money

One of the most attractive (and the most addictive) things about CFD trading is that you can operate sums much larger than your real investment. The reason is that physical assets are never actually bought or sold in this sort of trading, so the deals you make with seemingly grand sums remain virtual, and are soon closed with opposite deals, just as virtual. This lets a trader use a loan from the broker, actually covering just a share of it.

A sudden price change may, though, result in significant losses. The trader may after this appear in real debt, as the actual deposit used to take the loan (so-called “leverage”) may be insufficient to cover this. That’s where stop losses step in.

As the price reaches an undesired level, the contract is automatically closed. Yes, it’s a risk, but it’s the other side of the system that lets you earn more with fewer investments. In addition, in most countries authorities regulate leverages, preventing traders from getting into more trouble. So you need to find a decent broker to start your trading career.

 Calculate, Fantasize, Dare!

Of course, this is just the beginning. The world of CFD trading (as any trading) has a lot for you to learn about. If you discover that passion in you, soon you will learn hundreds of new words, speak numbers and trends, and make money where others don’t see it. So, good luck!